David A. Parke is a partner with
Bulkley, Richardson and Gelinas LLP, of Springfield, and a member
of the MBA Business Law Section Council. He co-authored The
Massachusetts Corporation: Legal Aspects of Organization and
Operation and authored Forming a Business Corporation Under Chapter
156D, and contributed to other publications and CLE programs.
An attorney who counsels the board of directors of a
Massachusetts nonprofit corporation must be mindful of some special
considerations that apply to a nonprofit board. This article will
review the responsibilities of directors of a Massachusetts
nonprofit corporation.
The directors of a nonprofit corporation perform functions that
are similar to those performed by the directors of a business
corporation. These include setting strategic goals, hiring and
evaluating the chief executive officer, approving budgets and
considering significant transactions involving the corporation.
However, unlike a business corporation, the board of a nonprofit
corporation must act to achieve a specific charitable or other
nonprofit mission. If the corporation is a public charity, the
directors are essentially trustees of the corporation's assets,
charged with properly applying those assets for the corporation's
specific charitable purpose. If the corporation has been recognized
by the IRS as tax exempt, the board must not allow any activities
to occur that would expose the organization to tax penalties or
loss of its exempt status.
Because nonprofit boards are often structured to satisfy a
development role, or to represent the community in which the
corporation operates, nonprofit boards tend to be larger and more
diverse than business corporation boards. Unlike boards of business
corporations, nonprofit boards typically consist of volunteer
directors. Because of these differences, counsel has an especially
important role in helping the board carry out its responsibilities
in accordance with law.
Duties of the directors
The duties of directors of a Massachusetts nonprofit corporation
are well established. A director must act in good faith, and
exercise fiduciary duties of care and loyalty. The relevant part of
the Massachusetts nonprofit corporation statute, M.G.L. Ch. 180,
Sec. 6C, states that a "director… shall perform his duties as such…
in good faith and in a manner he reasonably believes to be in the
best interest of the corporation, and with such care as an
ordinarily prudent person in a like position with respect to a
similar corporation… would use under similar circumstances."
There are other statutory and common law provisions that are
applicable to management of a charity under Massachusetts law.
M.G.L. Ch. 180A addresses the management of funds of a charitable
corporation. The Massachusetts nonprofit corporation statute,
M.G.L. Ch. 180, requires involvement of the Massachusetts Attorney
General before a public charity makes certain dispositions of
assets or dissolves.1 The board of a charity is limited
in its power to change the charitable purposes of the
corporation.2 As discussed below, the board is also
limited in its power to delegate control over the charity's
assets.
The requirement that a director act in good faith means that a
director must act in an honest manner. A director is not acting in
good faith if the director relies on third party information in
approving any action, where the director has knowledge that would
cause such reliance to be unwarranted. Failure of a director to
make a reasonable inquiry into facts that support the director's
decision on a matter may also constitute lack of good faith.
Failure to act in good faith can have significant consequences
including jeopardizing the director's right to indemnity by the
corporation or coverage under any directors and officers liability
insurance maintained by the corporation.
In exercising the director's duty of care, the director must
perform adequate due diligence as to any matter under consideration
by the board. The Massachusetts nonprofit corporation statute
permits a director to rely, under appropriate circumstances, on
reports and recommendations from others. A director may rely on
information from an officer or employee whom the director
reasonably believes to be reliable as to the matter presented; from
attorneys, accountants or other professionals as to matters that
the director believes are within such person's professional
competence; and from committees of the board as to matters
delegated to the committee which the director reasonably believes
merits confidence.3
The "business judgment rule" may be available to protect a
director from honest mistakes or errors in judgment. While the
business judgment rule is applied with respect to business
corporations in Massachusetts,4 it is not clear to what
extent the business judgment rule would apply to directors of a
Massachusetts nonprofit corporation. Under the business judgment
rule, courts defer to decisions of the directors, who are presumed
to have acted in the best interests of the corporation. Where the
business judgment rule applies, a plaintiff must challenge the good
faith or the investigative process of the board.
To comply with the duty of loyalty, a director must act in a
manner reasonably believed to be in the best interests of the
corporation. This means that a director may not improperly benefit
from transactions with the corporation, may not divert
opportunities that belong to the corporation, and must keep
confidential private information learned as a board member.
The director's compliance with his or her duty of loyalty will
be vigorously scrutinized by the courts when a director acts as to
a matter in which he or she has a conflict of
interest.5It is important that a nonprofit corporation,
especially one that is a public charity, adopt and implement a
conflict of interest policy. Where a director has an interest in a
transaction under consideration by the board, that interest must be
disclosed to the board. The interested director may not participate
in the consideration by the board of the proposed transaction.
Who may assert claims
There are some immunities and other protections available to
volunteer directors of a Massachusetts nonprofit charitable
corporation. However, failure of a director to properly comply with
his or her duties can still lead to individual exposure, and to
costly and embarrassing consequences to the nonprofit corporation.
Claims may be asserted by the Attorney General, the corporation, or
those acting in place of the corporation, and governmental agencies
such as the Internal Revenue Service.
The Massachusetts Attorney General is charged with enforcing the
due application of funds given or appropriated to a public
charity.6 The Attorney General has broad power to
challenge and seek appropriate remedies when the board fails in its
governance responsibilities. The Attorney General has, in recent
years, taken action to address executive severance arrangements,
compensation to outside directors, related party transactions and
conflict of interest matters, and fundraising practices, of
Massachusetts public charities.
A nonprofit corporation may also take action against a director
or former director who has breached his or her fiduciary
duties.7 In some cases, a director may have a duty to
cause the corporation to take action to address a breach of
fiduciary duty by another present or former director that adversely
affects the corporation.
The Internal Revenue Service has power to assess penalties
against directors and others who are involved in the approval of
excessive compensation arrangements, or other excess benefit
transactions, under the intermediate sanctions provisions of the
Internal Revenue Code.8 In an extreme case, a
corporation can lose its tax exempt recognition from the IRS.
Developments over the past several years, including the Federal
Sarbanes-Oxley Act of 2002, changes made by IRS to the Form 990
filed by tax exempt corporations, and certain reported abuses at
nonprofit corporations, have focused attention on good governance
practices. While many of the Sarbanes-Oxley requirements do not
apply to nonprofit corporations, some of its governance-related
requirements that are applicable to public companies, such as
establishment of an audit committee, providing for financial
expertise on the board, and adoption of internal controls, are
employed by nonprofit corporations.
The IRS Form 990 now asks a tax exempt corporation to disclose
various information regarding its governance, including information
regarding its independent directors, its establishment of a
conflict of interest policy, whistleblower policy and document
retention policy, and its process for determining executive
director compensation. There is an increased expectation by the
public of transparency in the management of nonprofit charitable
corporations. The Forms 990, and its disclosures regarding a
charity's governance, are publicly available on the Massachusetts
Attorney General's website.
Recommendations
Because of limitations on resources and volunteer time, it can
be challenging for smaller nonprofit corporations to be aware of,
adopt and follow all the best governance practices that are being
reported. The following are some basic things that counsel can do
to ensure that the nonprofit corporation is moving in the right
direction:
- Be sure the board has a sufficient number of
independent directors
Having independent directors becomes critically important when the
corporation must address related party transactions, and other
conflict of interest situations.
- Be sure that the board includes directors with the
appropriate expertise
In this regard, the board should include directors who have
financial management experience, who understand financial
statements and budgets, and who can interact effectively with the
corporation's auditors. Depending on the mission of the nonprofit
corporation, board expertise in other areas will be necessary.
- Observe corporate formalities
For any proposed matter that must be acted upon by the board,
counsel must consider what notice is required for a meeting of the
directors, how the meeting should be called and notice properly
given, how directors may participate in the meeting, and what are
the quorum and approval requirements for board action.
For certain extraordinary actions, approval of the members of the
corporation may be needed. In some cases, the board should meet in
executive session or in the absence of a specific director with a
conflicting interest. Minutes should be drawn that carefully and
accurately reflect the matters considered and actions taken. When
there is a potential conflict of interest by a board member, the
minutes should reflect how the conflict was handled.
- Carefully consider the limits on what may be delegated
or approved by the board
There are limits under Massachusetts law on the power of the
directors of a charity to delegate their authority to others. The
Massachusetts Supreme Judicial Court has held that the power of an
officer of a charitable corporation to bind the corporation,
without approval by the directors, must be more strictly construed
than in the case of a business corporation.9 The board
of a nonprofit corporation may not freely delegate authority to
encumber a substantial part of the corporation's assets, or to
transfer management of the charity's assets to another
authority.10
What this means is that the board, rather than the officers,
should consider and approve significant transactions involving the
corporation; the board should approve the relevant terms rather
than delegating authority to an officer to do so; and the board
should be aware of its limited authority when confronted with any
proposed transaction involving a transfer of management of a
significant part of the charity's assets.
- Make sure the board is adequately prepared to make its
decisions
Decisions about executive compensation, deployment of significant
corporate assets, investment of corporate funds, and entry into
ventures with other organizations may require a more developed
record for the board. The board should not be asked to make any
decisions without having adequate information, and in appropriate
cases, advice regarding standards that govern its decision
making.
For example, decisions about a chief executive officer's
compensation are often made under a compensation policy pursuant to
which data regarding comparable compensation of similarly situated
executives is made available. It may be appropriate to have a
report and recommendation from a committee that has been charged to
review issues on a particular matter on which the board is asked to
act.
- Diligently follow the conflict of interest
policy
This is an area where directors and the corporation have special
exposure. It is not uncommon for volunteer board members to have
relationships that from time to time may create a conflict with the
corporation. A nonprofit corporation must adopt a conflict of
interest policy, and once adopted, follow it carefully. This
includes obtaining regular disclosures from board members and
officers regarding potentially conflicting relationships.
With respect to any specific transaction under consideration, a
director must disclose any conflicting interest and permit the
board to determine, without participation by the affected director,
whether there is a conflict and whether the transaction is fair and
appropriate. Minutes should be kept that reflect the procedures
followed and actions taken by the board.
- Be prepared to guide the board when controversies
arise
There will inevitably be controversies where the board must make
difficult decisions. Counsel should be available to guide the board
with respect to its crisis management, and assist where internal
investigations must be conducted. Counsel can be particularly
helpful in advising where special litigation or other investigative
committees should be formed, and how board and committee activities
should be conducted, especially where preservation of
confidentiality and attorney-client privilege is important. Counsel
can help balance the often competing concerns regarding
transparency and public disclosure, and not taking any action that
would jeopardize the corporation's position in litigation.
- Make sure there is a process to assure succession in
the board
The Massachusetts nonprofit corporation statute contemplates that
a nonprofit corporation will have members who elect the directors.
In many nonprofit corporations, the board of directors is the same
body that has the power of the members. In a nonprofit setting,
where most or all of the members or directors can be volunteers, it
is not uncommon for a corporation to lose contact with members or
directors, or not maintain a good record regarding who are its
current members. In a small nonprofit corporation, there may be no
one who is charged with assuring that there is a continuation of
active directors.
Therefore, it is important for counsel, at the planning stage, to
consider how the corporation should be structured to ensure
succession in its board of directors. Counsel should also work with
the corporation to see that annual meetings and elections are held.
Nonprofit corporations can also deal with issues of succession by
establishment of a governance committee or nominating committee
that is charged with assuring that the corporate structure is the
most effective structure, that new board members are selected, and
that there is succession in management.
As discussed above, there are several areas where counsel can
assist in the good management of a Massachusetts nonprofit
corporation.
1MASS. GEN. LAWS ch. 180, §§8A and 11A
(2012).
2See Attorney Gen. v. Hahnemann Hosp., 397
Mass. 820, 836 (1986).
3MASS. GEN. LAWS ch. 180, §6C (2012).
4See Harhen v. Brown, 431 Mass. 838, 845
(2000).
5See Am. Disc. Corp. v. Kaitz, 348 Mass.
706, 711 (1965).
6MASS. GEN. LAWS ch. 12, § 8 (2012).
7See In re Bos. Reg'l Med.l Ctr. Inc., 328
F. Supp. 2d 130, 145 (D. Mass. 2004).
8I.R.C § 4958 (2006).
9See Bos. Athletic Ass'n v. Int'l Marathons,
Inc., 392 Mass. 356, 366 (1984) (holding that the board may not
delegate to the president of the Boston Athletic Association
authority to enter into an exclusive promotion agreement with an
outside firm for promotion of the Boston Marathon, on terms deemed
acceptable by the president).
10See Mass. Charitable Mech. Ass'n v. Beede,
320 Mass., 609-10 (1947).